How To Use Keltner Channels

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The Keltner aqueduct indicator belongs to a family of technical analysis tools called envelop indicators. Envelop indicators like Keltner aqueduct uses 1 lower band and ane upper band to create a dynamic channel around the price range of a fiscal instrument. Regardless of whether the asset is trading upwards, downwards, or sideways, envelop indicators can assistance define upper resistance and lower support levels.

A Keltner bands strategy can be a very powerful part of a technical trader's armory. However, knowing how to use a Keltner channel trading strategy appropriately based on the asset's price action and market context is the primal to developing a successful Keltner band trading strategy.

Download the short printable PDF version summarizing the key points of this lesson…. Click Here To Download

Before nosotros dive into explaining the inner workings of a Keltner channel trading system and discuss how to apply Keltner channels, you lot should acquire the basics of how to read whatever envelop based technical indicator first. Unless you fully sympathize the variables behind a technical indicator, you will not be able to fully comprehend what types of market weather the indicator can work best in or how to apply the indicator to fit your trading strategy.

Understanding the Keltner Aqueduct Formula

Keltner channel was introduced to the trading arena by a technical analyst named Chester W. Keltner, who offset described the indicator in his volume How to Make Money in Commodities, which was published in 1960. He initially used ten-day Keltner moving average bands to calculate the middle ring of the Keltner channel instead of the modern variety that uses a 20-period exponential moving average in the Keltner aqueduct settings.

In fact, the modern variety of Keltner aqueduct, found equally a congenital-in technical indicator in popular charting software, is the brainchild of globe-renowned commodities and futures trader, Linda Bradford Raschke, who is the Founder and President of coin direction firm LBRGroup, Inc.

The Keltner channel adding could be easily summarized with the following formula:

Centre Band = 20-Period Exponential Moving Average Value

Upper Channel = twenty-Period Exponential Moving Average Value + Multiplied Value of Average Truthful Range

Lower Channel = xx-Catamenia Exponential Moving Average Value + Multiplied Value of Average Truthful Range

You see, the current version of the Keltner channel is comprised by combining two separate technical indicators. The first component of the Keltner aqueduct is a xx-period exponential moving boilerplate, which acts as the middle band. The second element of the Keltner channel is a multiplied value of the Average True Range (ATR) indicator, which is usually gear up at a value of 2. This means that the upper and lower channels are always at a 2x ATR distance from the twenty-period Exponential Moving Average heart band.

Unlike simple moving boilerplate (SMA), the Exponential Moving Boilerplate emphasizes contempo price movement. Since the Exponential Moving Average reacts faster to the changing directional movement of the toll, the Keltner aqueduct tin can provide an accurate overall direction of the trend by smoothing the toll activity.

As yous tin imagine, the more volatile a Forex pair is, the wider the upper and lower channels will announced from the centre band. Therefore, experienced Forex traders oftentimes change the default Exponential Moving Average menstruum of the Keltner channel and set it within the range of x to 40 to best match the currency pair's historical cost action characteristics.

In dissimilarity, the Average Truthful Range indicator measures the "boilerplate volatility" of the Forex pair based on a predefined number of periods, where the default look back timeframe is oftentimes set at the last fourteen-periods. However, depending on the charting software and availability of indicator settings, you can also change the ATR look back period in order to tweak the Keltner channel indicator further, since the price action and volatility of each Forex pair is unique.

Hence, y'all can brand small-scale tweaks in its settings to fit a particular currency pair. Even so, most beginning and novice traders should stick to using the default Keltner channel settings until they have gained sufficient experience trading with Keltner channels.

Interpreting Envelop Based Technical Indicator Signals Like Keltner Channel

Likewise the Keltner channel, several other popular technical indicators fit the description of envelop based indicators. For instance, the Bollinger Band indicator is another pop example in this family unit of trading indicators.

The practical trading application of almost envelop based indicators are quite like, but depending on the particular indicator's formula, the dynamic channels can stand for a wide diverseness of interpretation of the asset'south price activeness.

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Figure i: Keltner Channels and Bollinger Bands are Among the Virtually Popular Envelop Based Technical Indicators

For instance, while both Bollinger Bands and Keltner channels describe channels around the price range, the main difference betwixt these two indicators is how the upper and lower, as well every bit the middle aqueduct values are calculated. Equally demonstrated in Figure 1, the Bollinger Band indicator uses a 20-period uncomplicated moving average for the middle band and draws its channels or upper and lower bands at a altitude of 2 standard deviations from the middle band. On the other hand, the middle ring of Keltner channel calculation is based on a 20-flow exponential moving average, where the upper and lower channels are drawn at an equal distance from an Average True Range value multiplier.

Unlike the Boilerplate Truthful Range used in the Keltner channel, the standard deviation value of the Bollinger Band does non stand for an average, and it creates more than precipitous edges on the chart. Hence, some Forex traders prefer the Keltner channel over the Bollinger Ring, equally it draws smoother channels that can sometimes offer higher quality signals.

Figure 2: Keltner Channels Tin can Provide Overall Marketplace Outlook and Generate Trading Signals

When the upper and lower channels of the envelop family unit of indicators movement in an up direction where the price continuously trades nearly the upper channel, Forex traders interpret this signal equally an upward trending market condition. Past contrast, when the channels are moving in a downward direction and the price continuously trades virtually the lower channel, the market is considered to be a downward trending market condition. However, when the Keltner channels remain apartment, and the price starts bouncing between the upper and lower channels without showing whatsoever directional tendency, Forex traders consider such market place condition as a consolidating or range bound market.

Currency price movements can typically stall and even tend to range for a brief period of fourth dimension during uptrends and downtrends. During minor pullbacks that resume the prevailing tendency, envelop based technical indicators help Forex traders recognize entry opportunities to add new or additional positions in the direction of the underlying tendency.

Many times, you tin can quickly place if the market is in an uptrend or downtrend, or consolidating within a range simply by taking a await at the Keltner channels. Then depending on the underlying atmospheric condition, yous would incorporate a Keltner channel trading strategy all-time suited for the particular market situation.

As discussed earlier, the upper and lower Keltner channels are always plotted at an equal distance from the 20-catamenia Exponential Moving Average. As these aqueduct extremes represent a multiplier of the boilerplate volatility of the currency pair, when the price goes above or beneath the Keltner channels, it signifies that the market place is trading outside of the average or normal price range.

Forex traders can translate such a market condition equally a betoken of a reversing trend or the first of a new trend depending on the price action and momentum around these dynamic Southward/R levels. However, if the Keltner channels remain flat and the price trades within the upper and lower bands of the Keltner channels without penetrating to a higher place or below, information technology signifies that the marketplace is range leap.

One of the best aspects of the Keltner channel is that it not only provides traders with an overall technical market outlook about the on-going trend, but information technology can as well indicate a potential trend reversal when the price reverses and crosses the opposite channel. Using a Keltner aqueduct strategy, you can generate actionable entry and exit trade signals that tin can offer a solid reward to risk ratio.

Examples of Trading Forex with a Keltner Channel Strategy

Many experienced FX traders prefer to combine multiple uncorrelated technical signals to confirm the trend before placing their live trade orders. When y'all are trading with a Keltner channel strategy, you should endeavor to apply an additional technical indicator to bolster the forcefulness of the Keltner signal.

In the following three examples, we will discuss how you can trade 3 unlike market conditions past combining a second technical indicator and build a comprehensive Keltner channel trading system.

Case of Using Keltner Aqueduct for Trading Breakouts

One of the best applications of Keltner channel in Forex is using the indicator to trade breakouts. Breakouts occur when the cost ends a previous consolidation and starts a new trend.

However, if you lot only rely on the Keltner aqueduct to trade breakouts, you may detect that yous are seeing a lot of false signals. The best style to trade a breakout scenario with the Keltner channel would exist to combine a trend signal indicator similar the Average Directional Index (ADX).

Figure iii : Trading Breakouts with Keltner Aqueduct and Average Directional Alphabetize

In figure 3, the EUR/USD price showtime broke out of the upper Keltner channel, which signaled that the previous consolidation flow may accept come to an end. Withal, savvy Forex traders would not only place a BUY guild at this point because the Boilerplate Directional Index indicator value (Bluish line) was notwithstanding beneath the reading of 25.

Many experienced Forex traders only consider a market to be trending when the Average Directional Index reading is above 20 to 25, and where the tendency intensifies when the ADX indicator reading goes above xl to 45 level.

Hence, in one case the Average Directional Index reading reached above the 25 level, and then y'all could have considered placing the Buy order with your banker.

The trickiest part of trading breakouts using a Keltner channel strategy is to know exactly when you lot should time your market entry. You lot should try to identify a psychological resistance level during an uptrend and a support level during a downtrend, in one case the following 2 conditions are met.

The price has penetrated and closed above the Upper channel or airtight below the lower aqueduct and started an uptrend or downtrend.
Average Directional Index confirms the start of the trend by showing a reading above 25

On this occasion, we found the resistance to be effectually the one.0935 level. If yous had placed a BUY lodge one time the EUR/USD price penetrated above the 1.0935 level, this trade would have proved to be a winner.

Example of Using Keltner Aqueduct to Trade Retracement Pullbacks

Aside from breakout opportunities, the Keltner channel tin can also provide y'all with retracement signals. Moreover, if you are already in the trade, y'all tin can too use these retracement pullback opportunities to increase your position size.

Figure 4: Trading Pullbacks with Keltner Channel and Stochastic Divergence

In figure 4, nosotros have practical the Stochastic indicator in combination with Keltner channel to observe a retracement pullback trading opportunity. To trade using this strategy, commencement, you lot need to wait for the cost to confirm the trend by breaking above or below the upper or lower Keltner channel. On this example, the GBP/USD price bankrupt below the lower Keltner channel and signaled a downtrend.

One time the tendency is confirmed, you should look for the price to start a retracement and achieve near the middle band of the Keltner channel, which is the 20-flow Exponential Moving Average. The cost can retrace back and reach all the manner to opposite Keltner aqueduct as well at times. The key here is that the price cannot suspension and close on the other side of the Keltner channel, which would signal a potential reversal of the merchandise.

The tertiary thing you need to watch in this pullback strategy is the Stochastic indicator reading to judge when the market is overbought or oversold. Here, the cost reached near the eye ring of the Keltner channel and the Stochastic indicator turned overbought, signaling a potential trend continuation to the downside.

In add-on to that, we also found a stochastic divergence on the price chart, which significantly improved the odds of the trade. Notwithstanding, it is not necessary that you lot wait for a stochastic deviation to utilise this Keltner channel strategy. A stochastic overbought indicate during a confirmed downtrend would be sufficient to confirm a potential trend continuation.

The trigger for this Keltner channel pullback strategy is a price penetration below the low of the bar that signaled the stochastic overbought condition. Equally you can see, we have identified this particular bar with the black arrow on figure 4. If you have placed a SELL order as soon every bit the GBP/USD toll penetrated below the low of this bar, this trade would have yielded some handsome profits.

Instance of Using Keltner Aqueduct During a Range Spring Market

Besides trending markets, if you are looking to trade during a range leap market place, you can still employ the Keltner channel and Average Directional Index combination. The beautiful thing nigh combining these two indicators is that during a consolidation period, the upper and lower Keltner channels will deed as resistance and support, where the Average Directional Index will confirm if the market is ranging or a new trend is likely to take place.

Figure 5: Trading a Ranging Market with Keltner Channel, Average Directional Index, and Toll Activity Bars

On figure 5, you can run into that the GBP/USD cost was trading sideways and the Keltner channels acted every bit support and resistance levels. As the Average Directional Index indicator reading remained below the 25 level, it confirmed that there is no underlying directional movement or trend in the market.

Such marketplace condition constituted a textbook sideways or ranging market, and it provided a trade opportunity if you lot knew how to read price action confined. On two occasions, the GBP/USD produced two bullish pin bars after coming close to the lower Keltner aqueduct, which acted as support. Moreover, the GBP/USD formed a bearish outside bar later coming close to the upper Keltner aqueduct, which acted as resistance. If y'all had placed an gild when the GBP/USD toll bankrupt these 3 price activeness bars, as identified with red arrows in figure 5, at least the first 2 out of three of these trades would accept turned out to be assisting.

Download the short printable PDF version summarizing the primal points of this lesson…. Click Here To Download

Conclusion

Similar other envelop based technical indicators, Keltner channel has its positive points and shortcomings. Yet, if you spend some time understanding the formula behind the indicator and combine it with other technical indicators to develop a trading strategy fit for unlike market conditions, such trading systems tin can generate positive returns to your bottom line.

It is worth noting that as of this writing, the popular Forex charting software MetaTrader 4 platform does not include any born indicator for plotting the Keltner channels. In order to draw mt4 Keltner channel, y'all can opt to download a third-party developed Keltner channel indicator. There are several versions of the Keltner channel indicator readily available for downloading at the official forum of MetaTrader four platform, the MQL4 Programming Forum. Furthermore, you tin also search for a custom Keltner channel indicator at diverse popular Forex forums, such as on ForexFactory forums.

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